Working Tax Credits: a timely guide for contractors
It’s a strong word that the tax authority would of course deny being, but we’ve seen a few cases where HMRC have tried to ‘bully’ taxpayers by not clearly giving reasons for refusing a claim for working tax credit, writes Darren Roberts, head of contractor services at Dynamo Accounts.
That’s what makes last month’s upper tribunal ruling in favour of a one-man band so refreshing. In it, the judge took a real-world, common sense approach. And not just when he threw out HMRC’s request to send the case back to the first tier-tribunal which (surprise-surprise), agreed with the Revenue that the grafting taxpayer was not eligible for the credit!
But contractors, you don’t want to have to rely on the likes of a Judge Nicholas Wikeley being around if you’re knowledge of working tax credits -- WTC -- gets picked on. Get clued up to avoid getting duffed up.
What are Tax Credits?
Tax credits from HMRC are designed for individuals and families on low income or that have children. They're a means-tested benefit. But that doesn’t mean contractors cannot qualify for both the Working Tax Credit and the Child Tax Credit (CTC).
And because you never know what could happen to your contracting career or income in the future, we generally recommend that you make a claim in any event. That’s our recommendation even if you do not qualify on the grounds of income levels. It’s a ‘just in case’ move you should make, because you may well qualify in later years due to either unintended time ‘on the bench,’ other unforeseen circumstances or the birth of a child.
The eligibility criteria tend to be updated by HMRC following the chancellor of the day’s Budget. However, they tend not to vary too much, although any adjustments to being able to qualify for benefits can be controversial.
Firstly, CTC. This is payable to parents and guardians with children and that are responsible for a child. The benefit would be available to a household with an income of less than around £25,000. But don’t let that stop you from applying. Those guardians or parents on higher income may still qualify, if they have more than one child, incur childcare costs or have a child with disabilities. Note, CTC is paid directly to the primary carer of the child.
Secondly, WTC. These are for those that qualify through being on a low income, working 16 hours or more each week, or no income (‘on the bench’ so out-of-contract). Positively though, even when in this jobless state, a contractor would qualify as working more than 16 hours a week by virtue of job searching, interviews, networking and maintaining knowledge, and so easily reaches the required number of hours for eligibility. Note, WTC is paid monthly by HMRC into the bank account of the claimant.
Calculating WTC, CTC
The calculation of tax credits is a highly complex affair, involving a number of different factors. This has been simplified in recent years but we still recommend seeking professional advice should you think HMRC’s calculations are incorrect. To crunch the numbers yourself, there is a benefits calculator available on the Direct.gov website -- helpful for double-checking benefits payments and eligibility.
This calculator knows that the factors determining the level of benefits you are entitled to includes household income; number of children, disabilities and hours worked, but there are others too.
The level of credits is additionally based on a reducing sliding scale depending on the household income -- so the more a contractor earns, the less is payable. Also, if a contractor lives alone, the benefit is calculated on their sole income. However if a contractor is married, living with a partner or in a civil partnership, then it’s assessed on the household income.
Don’t let this rule deter or delay you. Failing to claim on time could mean that a contractor could miss out on receiving any benefit. So if you think you're entitled, or could be entitled in the future, submit a "protective claim" which in effect sets down a marker just in case for future years. Note; the deadline for submission each year is July 31st, meaning that once you miss this date, you'll lose out for another 12 months.
Changes in Circumstances
As with most dealings with HMRC, it's important to keep them informed of any changes to personal circumstances such as reduction in income, a marriage, the birth of a child, or even an increase in income. This could have an effect on the amount of benefit due, either increased or reduced.
If a contractor delays in informing HMRC of any changes, it could result in a reduction in benefit; you could face a sudden or unexpected large bill for a clawback or repayment.
Don’t underestimate the significance of this. We've had a number of clients who have come to us on receipt of a revised HMRC calculation, seeking a large repayment of benefit! This revision can run into the several thousand pounds.
Again though, don’t be put off. Generally, HMRC are flexible over changes in circumstances in order to avoid any claw backs, it's therefore imperative that any updates are communicated to them as early as possible.
Adjusting Income Levels to Qualify
In order to qualify for credits, some contractors might be tempted to reduce the level of salary and dividends from their contracting company (a limited company, also known as a Personal Service Company, ‘PSC.’)
However HMRC are wise to this, and it is in fact illegal to do this for the purpose of qualifying for tax credits. But note, it is not illegal to retain funds in a company for sound commercial reasons. So just ensure that any adjustments to income are correctly documented, particularly in the event of an enquiry by HMRC at a later date.
Be advised though, there is legislation in place to prevent company directors from deliberately depriving themselves of income for the purposes of qualifying for benefits. HMRC takes this very seriously and has been known to disqualify directors from the WTC element, where there was no contract of employment in place and where they were not paying themselves for the qualifying 16 hours at NMW rates.
The Courage Plucking Up Process
Of course, it's very possible that a contractor would never qualify for tax credits. While you should be mindful of that, we still regard it as potentially worthwhile for you to complete the paperwork each year, just in case your earning power diminishes.
Also because you never know what's around the corner -- a place that bullies like to lurk, we recommend getting an accountant on your side. Ideally do this before you make a claim for credit and set your salary levels as a company director, partly so any paperwork can be put in place.
But we also suggest getting an adviser to back you up because we often wonder how many WTC or CTC contractor claimants have simply rolled over and accepted HMRC’s decision on eligibility, rather than challenge. Should you doubt the eligibility decision you receive, you should bravely persist and ask questions -- like the grafting painter and decorator did. Having someone who’s got your back during this process really helps. Either way, just stick up for yourself because doing so will provide the basis of a challenge should you, the taxpayer-contractor, think HMRC’s decision is unfair.